The Most Common Retirement Mistake (and How to Fix It)
Having a nest egg is important to U.S. workers, and we do our best to stash away funds for our golden years. However, an estimated 46% Americans are missing out on thousands of dollars every year with this major blunder: using a regular savings account instead of investing in a retirement plan. Here’s why using a basic savings account could be catastrophic to your retirement plans, and how to save for retirement the smart way.
Why shouldn’t you use a savings account for your retirement funds?
You can’t invest money that’s sitting in savings.
Once your money enters a savings account, it grows VERY slowly. Interest returns on a savings account, while technically very secure, are extremely small compared to returns from investment-based retirement plans.
Although more cautious savers may be nervous to put their savings into what seems like a volatile market, it’s really not as scary as it seems! Especially for those who are a decade or two from retirement—the risk of investment is reduced over time as you ride out the highs and lows.
Here’s an example: If you use a basic savings account to sock away $300 a month for 40 years, you’ll have about $175,000 in savings assuming a 1% annual return. If you invest $300 a month for 40 years in a 401(k), you’ll be cashing out your 401(k) at about $718,000 (assuming a 7% annual return). Quite a difference, right?
Retirement plans allow for significant tax savings
Savings accounts offer no tax breaks. Retirement plans, on the other hand, give you the opportunity to reduce your tax expenses in a few ways. Here are some examples:
- Tax reductions: Contributions to common retirement plans reduce your taxable income, making tax season far less stressful.
- Tax deferrals: Most contributions are tax-deferred, meaning you won’t pay taxes on them right now. Instead, you’ll be taxed during retirement, when you’re likely to be in a lower tax bracket. Investment gains on a traditional IRA or 401(k) are also tax-deferred.
- Tax- free withdrawals: Some retirement plans, such as Roth IRAs, allow you to withdraw money tax-free.
Is there ever a reason to use a savings account instead of investing?
Absolutely. A savings account allows for easier withdrawals for emergency expenses. Having some cash stashed away will prevent you from one major financial blunder: cashing out your 401(k) to cover unexpected events. Cashing out your 401(k) early comes with hefty penalties and should be avoided.
Is it too late to start investing?
It’s never too late, even if you’ve been using a basic savings account instead of a retirement plan. If retirement is approaching soon, you could move your savings into a high risk/high return investment option. If you have a couple decades to go, you might try an IRA or double down on employer-sponsored 401(k) options. Make sure you’re familiar with your options.
No matter your situation, it’s wise to speak to a trusted financial advisor to help assess your best investment opportunities. The right information could mean the difference between a comfortable retirement or a last-minute-saving-scramble. Best of luck and happy investing!